Commercial Real Estate for Sellers & the Legal Process
There are a few instances in which a person may find themselves selling commercial real estate. Two of the most common circumstances include business owners who are looking to move locations or otherwise close business at their current location and investors who buy and sell commercial properties for profit. Whether selling a commercial property is a one-time or frequent undertaking, sellers should always stay mindful of their rights and responsibilities and seek expert advice when appropriate.
Brokers and Fees
Commercial real estate brokers customarily participate in commercial real estate transactions and can help sellers by obtaining an appraisal of the property and identifying comparable properties (“comps”) in the seller’s area, both of which can help a seller set a good but competitive price. A seller should also account for fees and expenses associated with the sale to determine their break-even point.
Sellers will often pay for legal, broker, and title fees, other closing costs, transfer taxes, and, sometimes, the cost of terminating contracts not assumed by the buyer. Title fees will likely include the cost of the premium on the title insurance policy, which is usually a certain percentage of the purchase price. Transfer taxes are one-time fees imposed on the transfer of property and are only payable in some states or localities.
Capital Gains Tax and Section 1031
Sellers should plan how they will use the money from the sale before the closing date. They may opt to simply pay capital gains tax and pocket the profits, or they may have the option to reinvest the money. Under Section 1031 of the Internal Revenue Code, a seller may be able to reinvest their proceeds while deferring capital gains tax. To take advantage, they must identify a qualifying like-kind property within 45 days of the closing and close on the replacement property within 180 days. This means that a seller will need to move quickly and plan early.
If they are employing Section 1031, a seller will generally use a third party to act as a qualified intermediary. The intermediary will hold the sales proceeds in escrow between the sale and purchase. This is important because receiving proceeds before the 1031 exchange is complete will likely disqualify the entire transaction. A seller must identify at least one, but up to three, qualifying properties in writing to the qualified intermediary within 45 days of the sale of the property being replaced. A seller can identify up to three replacement properties without regard to their value, but more detailed rules apply if they choose to identify more than three properties. A seller cannot act as their own qualified intermediary, and neither can a seller’s agent, such as their broker or their lawyer.
A seller has 180 days after the sale of their previous property to complete the 1031 exchange by closing on their new property. If their tax return is due, including extensions, earlier than the 180-day window, the new property must be received before the due date of the tax return for the year in which the relinquished property was sold. It may be possible for a seller to purchase a replacement property first so long as they transfer the new property to an exchange accommodation titleholder, identify the property to be sold within 45 days of the purchase, and complete the sale within 180 days of the purchase, generally speaking. Sellers must submit Form 8824 with their tax return for the year in which they completed the exchange.
The advantage of a 1031 exchange is that a seller can trade one investment or business property for another (and another, and another) and avoid paying capital gains tax on the money they reinvest until they eventually sell the final property for cash or otherwise dispose of it. At this point, they would pay capital gains tax, and likely at a lower long-term gains taxation rate. This is the case even if they realize a profit through each swap.
However, there are many nuances to the tax law, and there could be tax implications beyond those described here. For example, exchanging a property with a large mortgage for a property with a smaller mortgage may result in taxable gain. Also, a seller will likely be liable for capital gains tax on any part of the sales proceeds that they decide to take as cash. A seller considering a 1031 exchange should seek the advice of a professional, such as a business lawyer.
